The National Taxation Bureau of the Ministry of Finance has recently reminded that where an enterprise makes substantive investments using its current-year earnings and claims a deduction in calculating undistributed earnings, any change in the use of the relevant assets within three years that does not comply with applicable requirements will result in a tax clawback, together with interest accrued on a daily basis. 

Pursuant to Article 6, Paragraph 1 of the Regulations Governing the Application of Deduction of Undistributed Earnings and Tax Refund for Substantive Investments by Companies or Limited Partnerships, an enterprise must satisfy the “substantive investment” requirement in order to qualify for the deduction. Specifically, buildings, hardware and software equipment, or technologies constructed or acquired using retained earnings must be actually used for the enterprise’s own production or business operations. In addition, within three years from the day following the filing deadline for undistributed earnings (or from the day following a corrected filing), such assets shall, in principle, not be lent, leased, resold, returned, or converted to non-business use. 

If an enterprise violates the above requirements within the three-year period, the tax authority will recover the previously deducted or refunded tax amount. Interest will also be imposed, calculated on a daily basis at the fixed interest rate for one-year time deposits of postal savings, from the day following the filing deadline or the date of receipt of the tax refund, until the date of payment. 

For example, if an enterprise purchases equipment in the relevant filing year and claims such investment as a deduction, but ceases operations and resells the equipment in the following year, such use would fail to meet the requirement of being “for the enterprise’s own production or business operations.” In such case, the enterprise would be required to repay the tax benefit obtained, along with the corresponding interest. 

Notwithstanding the foregoing, in consideration of practical business needs for corporate restructuring, the regulations provide certain exceptions. For instance, where assets are transferred as a result of a merger, demerger, or an acquisition conducted in accordance with the Enterprise Mergers and Acquisitions Act, to a surviving or newly established company, no tax clawback will apply, provided that such assets continue to be used for production or business operations by the transferee entity. 

Enterprises are advised to take note that, upon claiming a deduction in respect of undistributed earnings, the relevant assets should not be leased, disposed of, or otherwise repurposed within a three-year period, in order to avoid any potential tax clawback exposure.